Yellen and the Fed Go Dark

The Federal Reserve is shifting from myopic qualitative rules to vague qualitative forms of discretion.
No, I don't feel like clarifying my last statement. Photographer: Andrew Harrer/Bloomberg

It's hard to believe now, but the Federal Reserve used to keep its policy decisions a secret until weeks after the fact. Announcements at the end of each meeting, much less the detailed explanations and the news conferences, are all recent practices. The Fed's latest policy statement, and subsequent comments by the central bank's new chief, Janet Yellen, both suggest that some policy makers are having some second thoughts about the push for greater transparency. Opacity is back on the menu.

Compare the second-to-last full paragraph of today's statement to the last paragraph of the statement from Jan. 29. Gone is the so-called Evans Rule, which gave guidance about when the Fed would begin raising short-term interest rates based on a numerical threshold for unemployment. The rule was never very helpful anyway, because the Fed never said it would raise interest rates once unemployment fell below 6.5 percent, only that it would become less tolerant of inflation at that point. Since inflation is much slower than the target rate of 2 percent, the Evans Rule served only to confuse. In this case, less information about the Fed's intentions is clearly better.

What's intriguing is that the Fed tried to compensate for dropping the Evans Rule by emphasizing "a wide range of information" that would weigh on policy decisions. My favorite is the delightfully vague "readings on financial developments," which seems to give the Fed a pass to do whatever it wants for any reason it can invent.

Given the difficulty of interpreting the meaning of the statement, many analysts chose to rely on the individual predictions by Federal Open Market Committee members of the level of short-term interest rates at the end of 2015 and 2016. However, the range of estimates for 2016 is so wide as to be meaningless. That may explain, despite hints that the Fed has no plans to raise rates any time soon, why medium-term U.S. Treasury bond yields spiked and Eurodollar futures plunged. Just for good measure, Yellen said that the individual forecasts were worthless as a guide to future policy.

Yellen gave a clue about one thing she wanted to see before raising rates: faster wage growth. Wages now are growing a little faster than 2 percent annually, which is still far below the historical average. During the press conference, she said that she wouldn't want to increase rates until wages were growing at a more normal pace of around 3 percent to 4 percent annually. Unless you have a crystal ball that tells you what will happen with wages, this possible new target tells you almost nothing about when rates will be raised.

These developments suggest a desire to turn the clock back to a time when traders had to make bets without Fed hand-holding -- even if the Fed still does release its economic projections. A shift toward opacity might be wise. The economy is a complex system that no one fully understands, so it would be foolish to commit to any unbending numerical rule that limits policy makers' flexibility to react to unforeseen events. That was why former Chairman Alan Greenspan was opposed to formal inflation targets.

An additional benefit of opacity is reduced predictability. Scholars have found that financiers take too much risk when they think they know what will happen in the future, so muddying the waters may be just what's needed to promote a safer financial system.

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